Getting A Mortgage After Short Sale or Foreclosure

Just a couple of years ago, Lisa and Laura (names changed for privacy) were caught in a housing nightmare. They had moved back to Sarasota, Florida from Nashville, Tennessee at the height of the housing market boom, and rented an apartment just long enough to decide they wanted to own their own home again.

They found a home in a community they really liked. It was a fixer upper that needed a lot of work, and the sales price was $365,000, but they jumped at it. “At that time there were lines of people waiting to buy, and there were bidding wars,” Lisa explains.

Within a couple of years, though, their home’s value had dropped by more than half. They had also put about $30,000 into repairs using a separate second mortgage, but the punch list just kept getting longer. “We were looking at (the decline in value) plus the fact that we needed a new roof; pool resurfacing and a new pool cage; plus a new kitchen, bathrooms, air conditioning and more,” says Lisa.

At that point they decided to cut their losses, and they got lucky. Their lenders allowed them to sell their home for $180,000 in a short sale. The mortgages totaled $435,000, so the banks took a total loss of $255,000. The remaining debt was forgiven. “We didn’t owe anything when it was done,” explains Laura.

After that harrowing experience, you might think they would never want to buy again. Once burned, twice shy, perhaps? But Lisa and Laura realized what a lot of experts are saying: it can be a great time to buy a home if you qualify. Mortgage rates are low, and home prices are within reach in many areas of the country.

But buying after foreclosure or short sale isn’t as common as one might think. Since the housing downturn, Sarasota-based real estate professional John Scherden has found himself working with many buyers and sellers involved in the short sale process. Buyers who were in bidding wars when prices were twice what they are today are often skittish now. “They don’t realize that when rates go up, they may not have the opportunity they have right now,” he says. John finds that buyers often focus on the monthly payment and waiting to purchase after mortgage rates have gone up will substantially increase their monthly payments and the overall cost of the property.

Deciding to jump in again, the couple’s main questions for me were, “How long do we have to wait after the short sale to buy?” and “What do we need to do to clean up our credit to qualify for a mortgage?” (For the record, I don’t offer credit repair services. I agreed to help Lisa and Laura in order to write about their experience for this article. If you have questions about your credit, I recommend you visit Credit.com where I and other experts answer questions for free.)

Reviewing their credit reports, we found several issues that needed to be addressed:

Lisa’s credit reports show several older collection accounts from bills they didn’t receive when they moved back to Florida.

Laura’s credit reports show a $5000+ charge off from a corporate card her previous employer had not paid.

Lisa’s credit report showed the short sale, just over two years ago. She had obtained the mortgage on their previous home alone so it was not listed on Laura’s credit reports. It was just over two years old.

With regard to the collection accounts, I explained to both of them that paying a collection account generally doesn’t help boost your credit scores. However, mortgage lenders may sometimes require you to pay them off before the loan closes. I also explained that they may be able to settle those collection accounts for less than the full amount owed, and still bring the balance listed on their credit reports down to zero, but I wanted them to talk with a loan officer first. Credit strategies can be different when you are trying to get a mortgage loan, and I didn’t want them to do anything to jeopardize that.

To answer their question about how soon they can get a loan after a short sale, I turned to Joe Kelly at ArcLoan.com, who in turn asked one of his loan officers, Carrie Chienyuen, to review their credit reports and financial situation, and explain their options.

Carrie shared the latest Fannie Mae guidelines with us. After a deed-in-lieu of foreclosure, preforeclosure sale, or short sale, there is a mandatory waiting period of two years for a loan with an 80% maximum LTV (loan-to-value ratio), or four years for a loan with a 90% LTV. If the borrower can document extenuating circumstances, the waiting period for a loan with a 90% LTV drops to two years.

Since the couple had the money for a down payment, they could get back in the game if they were ready. Carrie also explained that another option: Laura could try to qualify for the loan on her own. They could still hold title to the home jointly, even if Lisa wasn’t a co-borrower.

Carrie also described FHA guidelines, which are even more generous. The couple could get an FHA loan with a down payment of only 3.5%. The APR at the time of the quote was a jaw-dropper, at less than 5%. (Keep in mind rates can change daily, and depend on individual circumstances.) FHA requires a three-year wait after a short sale or foreclosure, however.

Carrie warned that if they were to get a conventional loan, they would probably have to pay off the collection accounts first. But with an FHA loan, it likely wouldn’t be required. In the meantime, Laura is trying to work with the card issuer to resolve the corporate card account, by far the largest collection account listed.

Not surprisingly, the two were thrilled at the prospect of getting a do over. They will decide shortly whether they want to make the plunge back into homeownership. But more importantly, they feel like they are starting to gain a sense of control again.

“I know there are a ton of people out there like us, and I know I feel so lost with everything that’s happening with the economy,” said Laura.

If you’re thinking of buying a home after going through a foreclosure, short sale, or other credit problems, I recommend you:

1. Get your credit reports from AnnualCreditReport.com or a credit monitoring service and review them carefully. Make note of anything you don’t understand. If you are hoping to get a mortgage soon, don’t dispute or close accounts until you have talked with a loan officer.

I am not trying to imply that getting a mortgage after foreclosure or bankruptcy is going to be a walk in the park. I am sure plenty of loan officers who read this can recount lots of hassles they’ve gone through with their clients. Lenders are much more careful than in the past, and you must be able to document your ability to pay the loan. Your credit must be on the mend as well. But still, if you’re in the same boat as Lisa and Laura, it can be encouraging to know that it may be possible to put your past behind you – possibly sooner than you think.